1. Valuation Issues for ASCs
5th Annual Orthopedic, Spine, Neurosurgery and Pain Management Driven ASC Conference
June 16, 2007
Presented by:
Todd J. Mello, Principal, HealthCare Appraisers, Inc.
Todd J. Sorensen, Partner, VMG HEALTH

2. ASC Valuations Presentation Outline
Valuation Framework
Factors Affecting Value
Valuation Approaches
Selection and Application of Appropriate Approaches and Methodologies
Valuing Minority Interests
Issues Related to Recurring Transactions
Other Valuation Issues

3. Valuation Framework What is the ownership interest being valued?
What is the purpose of the valuation?
Pending transaction (e.g., a physician buy in/out or a transaction with a hospital or an ASC company)
Compliance with federal ASC safe harbors and IRS private inurement issues
Shareholder disputes/litigation
What is the standard of value?
Fair Market Value (“FMV”)
Fair Value
Investment Value
What is the premise of value?
Going concern
Liquidation
Scope Limitations

4. Valuation Framework

5. Definition of FMV Internal Revenue Service Revenue Ruling 59-60
“the amount at which property would change hands between a willing seller and a willing buyer when the former is not under any compulsion to buy and the latter is not under any compulsion to sell and when both have reasonable knowledge of the relevant facts.”
Stark II
“the price an asset would bring as a result of bona fide bargaining between well-informed buyers and sellers who are not otherwise in a position to generate business or compensate the other party”

6. Valuation Guidance from the IRS
Revenue Ruling also states that all relevant factors should be considered, including the following:
the nature of the business and history of the enterprise from its inception;
the overall economic outlook, and the condition and outlook of the specific industry in particular;
the book value of the stockholders' equity and the financial condition of the business;
the earning capacity of the company;
the dividend-paying capacity of the enterprise;
sales of the stock and the size of the block to be valued; and
the market price of publicly traded stock of corporations in similar industries or lines of business.

7. Valuation Issues Specific to ASCs
Physician ownership makeup or lack thereof is critical
Physician risk is the most important risk factor in ASC valuation
Value related to distributions (i.e., dividends) as compared to capital appreciation – much higher liquidity built into investment
Divestiture typically required upon retirement, relocation, and inactivity – buyout typically formulaic or fair market value
Importance of restrictive covenants
Numerous regulatory hurdles – anti kickback statutes and potentially private inurement regulations
Publicly traded corporations are not generally relevant comparisons
Sales of similarly sized blocks of stock often not comparable
In valuing entity, important to understand uniqueness of industry

8. Primary Factors Affecting Value
Case volume, mix, and reimbursement
Impact of potential change in Medicare Reimbursement
Orthopedics +77%
Pain Management -20%
General Surgery +58%
GI -23%
Growth in volume and reimbursement
Diversification (e.g., # of surgeons, number & type of specialties, payers)
Size of physician ownership, appropriate non-competes and ability to attract new investors
Nature of payer contracts; is there a substantial portion of “out of network?”
Ability to generate sustainable cash flow from operations and on-going distributions
Financial leverage, working capital, and on-going capital expenditures
Quality and age of facility and equipment
Opportunities for expansion (rooms, surgeons)
Competent management
Barriers to entry (e.g. CON)

9. Valuation Methodologies Primary Valuation Approaches
Asset Based Approach
Market Approach
Income Approach

10. Valuation Methodology Selecting the Valuation Approach and Methodology
Asset Based Approach
PURPOSE: Measures the value of an ASC by identifying and individually valuing the ASC’s tangible and intangible assets and liabilities. Based upon the Principle of Substitution; i.e., the premise that a prudent individual will pay no more for a property than he/she would pay to acquire a substitute property with the same utility.
Asset-based approaches are useful when:
The ASC has no expected earnings or other attributes of value whereby an “orderly liquidation value” yields the highest valuation; or
To establish a “floor” of value when using other valuation methods

11. Valuation Methodology Selecting the Valuation Approach and Methodology
Market Approach
PURPOSE: Measures the value of an ASC by evaluating comparable companies and/or transactions in the marketplace. Also based on Principle of Substitution.
Market Approach includes:
Guideline Publicly Traded Company Method – not applicable here
Comparative Transaction Method – depends
Market Approach may be more relevant if:
Valuing a controlling (as opposed to a minority) interest
Truly comparable entities are available

12. Valuation Methodology Selecting the Valuation Approach and Methodology
Income Approach
PURPOSE: Measures the value of an ASC by determining the present value of its expected future cash flow stream.
Income Approach includes:
Capitalization of Earnings Method
Discounted Cash Flow Method
Income Approaches may be more relevant when:
The ASC is generating significant, normalized cash flow from operations to fund ongoing distributions
When valuing minority interest in cash flowing centers
When the ASC has significant intangible value and when reasonable market comparables are not available

13. Valuation Methodology Decision Tree
ASC
Attributes

14. Valuing Minority Interests
Simply stated: Interests providing absolute control (i.e., greater than a 50% interest whereby key aspects of control are not diminished by governing documents or otherwise) are worth more than interests which do not have the same control rights
Control granted by the governing documents (examples on next slide)
Concept of “effective” control – physicians control with their feet
Valuation Guidance: absence of control adjustments in financial projection (preferable approach) or application of minority interest discount (reliance on published studies or other; more difficult to quantify and support)
Control premiums are often paid over and above fundamental value
Management Agreements
Control premiums typically do not exist in ASC equity interests that exhibit high levels of physician risk

15. Valuing Minority Interests Matters Subject to Control
Capital Calls
Admission of new investors
Borrowings greater than a certain amount
Acquisition of equipment greater than a certain amount
Selling, assigning or otherwise disposing or encumbering assets
Entering into material contracts
Selling, liquidating, or merging the entity
Changing the core governing documents
Typical ASC ownership agreements are very friendly to the minority shareholder
Note: Physicians display a certain level of control regardless of ownership interest level

16. Issues Related to Recurring Transactions
Buy ins are subject to greater regulatory scrutiny – anti kickback statutes
Use of an independent FMV appraisal achieves the greatest regulatory comfort
Consider asking a valuation firm to develop a mechanism to “roll forward” the valuation analysis
Typical Multiples of 3.5 to 4.0x Trailing EBITDA
Language addressing situations where historical earnings are not likely representative of future performance (Recent loss or addition of physicians, reimbursement changes, CAPEX needs, etc.)
Consider engaging the valuation firm to prepare or review the “roll forward” for each transaction

17. Other Valuation Issues
Discounts for lack of liquidity/marketability
Developed but not yet operational (value “in place” is greater than equity in underlying fixed/tangible assets?)
ASCs at an “inflection” point and importance of projections

18. Todd J. Mello, MBA, AVA, Principal HealthCare Appraisers, Inc
Todd J. Mello, MBA, AVA, Principal HealthCare Appraisers, Inc. 858 Happy Canyon Road, Suite 24C Castle Rock, Colorado (303) Todd J. Sorensen, Partner VMG HEALTH One American Center 3100 West End Avenue, Suite 940 Nashville, Tennessee (615)